2011 International Conference on Economics and Business

Information
IPEDR vol.9 (2011) © (2011) IACSIT Press, Bangkok, Thailand

Transfer Pricing: Headache to Corporate Governance

Swami Bonu *
University of Botswana, Gaborone, Botswana

Abstract. Fixations of transfer pricing (TP) is problematic to corporate governance (CG) as there are
various constraints such as legal issues, pricing methods, documentation, penalties influence and are
applied differently across the globe. The aim of the paper is to locate such constraints through literature
review and comparative analysis of management of TP in various countries. The research confirmed TP
as headache to CG and hence suggested to incorporate TP guidelines in the respective country’s Company
law and OECD to act as “International Court of Justice” in the area of TP conflicts.
Keywords: Transfer pricing, Corporate Governance

1. Introduction
TP is a system of charging price by an enterprise that enters into international cross boarder
transaction with an associated enterprise. For tax saving, TP is manipulated that resulted in revision of
TP system in US [1]. “New TP rules require more proof that internal transactions at multinational
companies are conducted at arm's length price (ALP)” [2], a price that is available to any unrelated party
in open market conditions. Internal Revenue Service (IRS) of US, OECD and many countries across the
world issued many complicated “regulations” on how TP is to be handled. The lack of harmony in TP
regulations created headache to CG to administer them, more so in the areas dealing with legal issues,
method of pricing, documentation and penalty. The old regulations didn't require much documentation
whereas the revised regulations require pricing at arm’s-length [3] with or without a markup and the
connected documentation. Revenue agencies and CG stand at opposite ends in dealing with TP as the
former desires to secure more revenue through taxes and the later tries to save more through dodging
taxes so as to secure more profit after tax to declare dividend.

2. Literature Review
The TP Guidelines for Multinational Enterprises and Tax Administrations provide guidance on the
application of the ALP for the valuation, for tax purposes, of cross-border transactions between associated
enterprises [4].
New CG is a broad spectrum that covers many practices which are not compatible with the formal
rules of CG more so in areas of TP, share dilution, asset stripping, limiting shareholder’ voting rights and
bankruptcy [5]. TP in the CG takes lead when a company is having its branch outside of the country.
Through TP “billions of dollars related to tax heaven, flow across borders” [6]. Australian Taxation
Office (ATO) noticed the abuse of TP to avoid tax through “corporate restructures” [7]. The application
of a specific method of TP out of many methods [8] [9] adds headache to CG. Though TP system is
designed to be consistent with accounting theory but it is not in operation [10].

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 Almost every corporate scandal of recent years, from Enron to Parmalat, has involved tax-dodging in
one form or another. There is a bull fight between the Revenue Authorities and CG. It is aptly said TP is
a global headache and is very tricky. Most countries set ALP but the practice is complicated particularly
companies are increasingly service-oriented and rely more on brand, intellectual property and other hard-
to-price intangibles. Haishun [11] noticed in China the headache created by TP on CG and recommended
to further liberalize the economy and develop a well-defined legal system to govern business operating
environment which includes fixation of TP.
• Professor Accounting ; Tel: + 267 355 4061; Fax: +267 355 4555; E-mail: bonuns@mopipi.ub.bw
Bernard [12] identified that CG behavior has a powerful effect on market value in a country where
legal and cultural constraints on corporate behavior are weak and thereby there will be further headache
when dealing with the TP. Suppliers of finance to corporation require return and the return could be
available from the balance profit after tax. This system added to the problems of CG as less tax (no tax),
more return and vice versa [13]. Chong et al. [14] and Porta et.al. [15] supported several theoretical
predictions that the legal approach is a more fruitful way to understand CG and its reform than the
conventional distinction between bank-centered and market-centered financial systems. Han [16]
investigated the impact of CG on the choice of TP methods in China and concluded that the ownership
has an impact on the choice of TP methods.
Martine [17] is of opinion that cross-border TP is difficult to fulfill the fiscal requirements which
created headache to the CG. Still CG plays a “key role” in fixation of TP to establish a balance with
various good reasons, while playing different roles at different levels to reflect strategic goals.
The prescribed methods where CG can choose under ALP such as (a) Comparable Uncontrolled Price
Method (CUPM) (b) Resale Price Method (RPM) (c) Cost Plus Method (CPM) (d) Profit Split Method
(PSM) and (e) Transactional Net Margin Method (TNMM) further created headache in the areas of
documentation (exhaustive & requirement of various certificates), burden of proof (rested on the
corporation) and heavy penalty (in case of understatement of income).
In addition to the above each country may have different laws, for example in India, Income Tax Act,
1961, Customs Act, 1962, Central Excise Act, 1944 and Accounting Standard 18 varied their approach in
dealing with TP issues. Divergent approaches in defining a transaction, associated enterprise and basis of
determination of price etc. further added salt to CG headache.

3. Constraints adding headache to CG in the area of TP

Among various constraints, this paper concentrates in the areas of legal position, pricing method,
documentation and penalty that add salt to headache to CG in handling TP. Legal position deals with the
laws of the country that are applied for TP. Pricing Method is the method among various methods such
as CUPM, RPM, CPM, PSM, TNMM etc allowed to be applied in TP. Documentation deals with
documents that are legally to be provided in TP which include background information on the commercial
environment when the international transaction entered into, the analysis carried out to select the most
appropriate pricing method in relation to ALP, certificate of an accountant certifying that the ALP has
been determined in accordance with the TPR and that prescribed documentation has been maintained [18].
Penalty is the area that attracts if the CG failed in the TP. As stated that TP deals with different countries,
it is problematic to CG to follow the contradicting legal system, rules etc of two or more different
countries and to satisfy the Revenue Authorities of the various countries. Never the less, it is a wanted
headache which requires medicine to prevent or cure the headache. It is always better to analyze the
problem creating areas in TP, identify the reasons and apply the preventive or curative treatment which
should satisfy both Revenue Authorities and the CG.

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4. Headache in fixation of TP at global perspective.
It is seen that fixation of TP has become a great headache across the corporations in the globe. It is
ideal to scan through the problematic areas of TP in different countries whether there is uniformity in the
problems and approaches in TP. As case study, countries such as Argentina, USA, Canada, U.K.,
France, Germany, Russia, India, China, Indonesia, Japan and Australia are taken up to pinpoint the
divergence in dealing TP issues and presented in the Table 1.
Table 1: Divergent approaches in dealing TP issues by different countries across the Globe

Country Legal Position Pricing Method Documentation Penalty

Argentina Tax Act & ARS Best method out of many Contemporaneous 3% interest monthly
methods for late, 2-10 times
fine un paid taxes
USA IRS Best from CUP, Resale Contemporaneous 20% - 40%
Price, Cost Plus, CPM, underpayment of tax
Profit Split as penalty levied.
Canada Tax Act & Method which provides Contemporaneous 10% penalty on total
CCRA highest comparability adjustment to
between transactions transaction plus non-
deductible interest
UK Income & Transaction based method Contemporaneous Up to 100% of any
Corporate Tax additional tax due
Act; IRD
France Tax Transaction- Documentation 40% for bad faith
Administration Based method. audit purposes. 80% for fraud

Germany Federal Ministry Transaction based No specific No penalty

of Finance method provision
Russia Russian Tax CPU method No specific rule No specific TP Penalty
Code
India Finance Act Best of CUP, Resale 13 Different types 100% to 300% of the
2001; IT Act, Price, CPM, Profit Split, of documents tax sought to be
CBDT TNMM, or CBTD evaded and others.
prescription.
China Income Tax Best out of CUP, Resale No statutory 2000 to 10000 Yuan
Law; SAT Price, Cost Plus requirement and others.
Indonesia Income Tax Best of CUP, CP M, No formal 2% to 48% of any tax
Law Sales minus resale price requirement underpayment
method discovered.
Japan NTA & STML Transaction based No Statutory but No penalty but general
suggested tax penalty provisions
documents apply.
Australia Income Tax Most reasonable method Contemporaneous Under TR98/16,
Assessment Act among CUP, Resale provision for penalty.
& Taxation Price, Cost Plus, Profit
Rulings Split, TNMM

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Notes: ARS= Argentina Revenue Service; IRS= Internal Revenue Service; CCRA= Canada Customs & Revenue Agency; IRD = Inland Revenue
Department; SAT = State Administration of Taxation; CBDT = Central Board of Taxes; NTA= National Tax Administration; STML = Special Taxation
Measures Law.

Table 1 high lights that there is no uniformity in the applicable variables tested such as legal position,
pricing method applied, documentation and penalty. Each country is having its own approach and hence
it becomes further headache for CG dealing in fixation of TP applicable (or suitable) in another country.
Even, within the same country, the rules and regulations are confusing and contradicting. This confusion
has given rise to many court cases. In order to stream line the TP regulations, Government of India
appointed an Expert Group which drafted TP regulations.

5. Indian Context
India, since 2001 has been amending its Income Tax Act to catch up strides of the international
developments regarding TP issues. The ALP is the core principle followed for computing transfer prices
in respect of transactions between related entities. The Assessing Officer can determine the ALP after
making adjustment in respect of the price charged or paid. The penalties up to 300% are also prescribed in
the law to curb tax avoidance by abuse of legislation [18]. India followed the suit of US and OECD and
amended its TP regulations accordingly. Courts also issued specific rulings on TP such as in Maruti
Suzuki India Ltd [19] allowed certain expenses in arriving at taxable income on TP system [20]. Re Dana
Corporation [21] court case dealt with the application of TP law on capital gains in business
reorganizations at international level [22].

6. Conclusion and suggestions

It is seen that Tax Law of the country is most influencing law in TP, still we could locate, other laws
within the country and global practices confuse the system of TP. Most of the countries followed ALP,
yet identifying the reasonable ALP is severe headache to CG. Documentation varies from country to
country yet too many such as 13 in India, definitely adds the salt to CG headache. Penalty is not uniform
across the globe; hence CG has to be careful in dealing TP.
The suggestions emanated from the Expert Group in India on TP aptly fit here such as TP guidelines
to be incorporated under the Companies Act to ensure the fairness of TP from a shareholder/creditor
perspective. “Abuse of CG by violating investor and creditor rights damaged the financial system. On the
one hand, the erosion of investor confidence has dealt a body blow to our capital markets. On the other
hand, mounting corporate delinquencies have debilitated the banking system. In this situation, it could be
argued that there is a case for a regulatory regime to check transfer-pricing abuses” [23]. Further it is
suggested a world body such as OECD should be empowered with legal powers as International Court of
Justice in dealing with TP issues.

7. References
[1] D. Canale. Transfer Pricing, Ernst & Young. (For more, see CFO magazine's "Heaven or Hell?" 2010.
[2] S. Helen. New Transfer Pricing Regulations, New Headaches. Today in Finance. 2006. Web ref:
www.cfo.com/article.cfm/7245815/c_7245271?f...retrieved on 9 Sept. 2010.
[3] B. Ackerman. Ernst & Young’s America’s leader for Transfer Pricing services. 2007.
www.cfo.com/article.cfm/7245815?f=related – retrieved on 17 Sept. 2010.
[4] OECD. The TP Guidelines for Multinational Enterprises Centre for Tax Administration. 2010.
[5] A. Yuko. The Ambiguous Affects of Russian CG Abuses of the 1990s. Post-Soviet Affairs, 1990, 22 (1): 65-
89.

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[6] L. Mehrene. Sources of Polarization of Income and Wealth: Offshore Financial Centres. Review of Radical
Political Economics. 2009, 41 (3): 343-351.
[7] B. Kate. Tax Watch on Transfer Pricing. BRW, 2007, 29 (36): 68-68.
[8] Horngren, C.T., Datar, S.M. and G. Foster, G. Cost Accounting: A Managerial Emphasis. NJ, Prentice Hall
2010.
[9] C. Correia, K.M. Smith, H. Thorne, and R.W. Hilton. Management Accounting: Information for Managing
and Creating Value. London, McGraw Hill, 2008.
[10] T.B.B. Peter. Transfer Pricing Management Information Systems. MIS Quarterly, 1997, 1 (1): 27- 35
[11] S. Haishun. DFI, foreign trade and Transfer Pricing. Journal of Contemporary Asia. 1999, 29 (3): 362-383.
[12] B. Bernard. The Corporate Governance behavior and market value of Russian Firms. Emerging Markets
Review. 2001, 2 (2): 89-108
[13] A. Shleifer, and R.W. Vishny. A Survey of Corporate Governance. The Journal of Finance, 1997, LII (2).
[14] Chong-En Bai, Qiao Liu, Joe Lu, Frank M. Song and Junxi Zhang. Corporate Governance and Market
Valuation in China. Journal of Comparative Economics. 2004, 32 (4): 599-616.
[15] R.L. Porta, F.L.D. Silanes, A. Shleifer and R. Vishny. Investor protection and Corporate Governance.
Journal of Financial Economics, 1999, 58 (1-2): 3-27.
[16] Han Xue. The Impact of CG on the Choice of Transfer Price. 2009.
[17] Martine. Cross-Border TP: A Corporate Governance Perspective, Erasmus University, the Netherlands, 2005.
[18] Government of India, Income Tax Act of India, 1961 as amended to-date
[19] Maruti Suzuki India Ltd (MSIL), Delhi High Court Case, New Delhi, July 6, 2010
[20] K.R. Srivats. Transfer Pricing: Maruti allowed tax deduction on ad spend. Delhi High Court disagrees
with tax authority’s contention. The Hindu Business Line, July 6, 2010.
[21] Re Dana Corporation Case. Before the Authority for Advance Ruling (Income Tax) New Delhi 30 Nov.
2009.
[22] V. Niranjan. Restructuring Companies: Capital Gains and Transfer Pricing. Retrieved on 3 Dec 2009,
indiacorplaw.blogspot.com/2009/.../restructuring-companies-capital-gains. Html
[23] Expert Group on Transfer Pricing, India. Report on Transfer Pricing. Government of India, Ministry of
Finance & Company Affairs, Department of Company Affairs. 2002.

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